BEWARE, IRA CONVERSIONS MAY ELIMINATE ADOPTION TAX BENEFITS

The new adoption tax benefits made available to adopting parents by the passage of the Small Business Job Protection Act of 1996 (H.R. 3448) are clearly explained in the October 1997 issue of The CPA Journal by Foster and Bolt-Lee. In the same issue, new savings incentives made available to taxpayers by the passage of The Taxpayer Relief Act of 1997 are discussed by Colburn and Englebrecht.

For adoptive parents, there is an important connection between the two acts. Under the 1997 act, IRA investors may convert their regular IRAs into a Roth IRA. However, under the 1996 act, the adoption tax benefits are phased out for taxpayers with modified adjusted gross incomes (AGI) between $75,000 and $115,000. It is important to recognize that the money converted from a regular IRA into a Roth IRA will be treated as ordinary income which will increase the modified AGI and may result in the elimination of tax benefits for some taxpayers.

For IRAs converted in 1998, the income can be spread over four years. In contrast, for IRAs converted in 1999 and thereafter, the entire amount of IRA conversion will be ordinary income in the year of the conversion. For example, a couple with a modified AGI of $36,000 is eligible for adoption tax benefits. If the couple were to convert a $80,000 regular IRA in 1998, they would still be eligible for adoption tax benefits since their modified AGI would be $56,000. However, if the couple were to convert the $80,000 regular IRA in 1999, they would be ineligible for adoption tax benefits since their modified AGI would increase to $116,000.

In summary, adoptive parents need to examine the value of adoptive tax benefits versus the value of a regular IRA rollover into a Roth IRA. Adoptive parents may find it more beneficial to postpone IRA rollovers to a year where they do not qualify for adoption tax benefits. *

Robert Kunkel
Assistant Professor of Finance
Matthew Monippallil
Professor of Accounting
Eastern Illinois University